risk

Examples of risk in the following topics:

• Approaches to Assessing Risk

  • Since planned actions are subject to large cost and benefit risks, proper risk assessment and risk management for such actions are crucial to making them successful.
  • As risk carries so many different meanings, there are many formal methods used to assess or to "measure" risk.
  • In enterprise risk management, a risk is defined as a possible event or circumstance that can have negative influences on the enterprise in question.
  • In a financial institution, enterprise risk management is normally thought of as the combination of credit risk, interest rate risk or asset liability management, market risk, and operational risk.
  • In project management, risk management can include: planning how risk will be managed, assigning a risk officer, maintaining a database of live risks, and preparing risk mitigation plans.

• Reinvestment Risk

  • Reinvestment risk is the risk that a bond is repaid early, and an investor has to find a new place to invest with the risk of lower returns.
  • Reinvestment risk is one of the main genres of financial risk.
  • Reinvestment risk is more likely when interest rates are declining.
  • Pension funds are also subject to reinvestment risk.
  • Two factors that have a bearing on the degree of reinvestment risk are:

• Types of Risk

  • Prepayment risk is the risk that the buyer goes ahead and pays off the mortgage.
  • Credit risk or default risk, is the risk that a borrower will default (or stop making payments).
  • Liquidity risk is the risk that an asset or security cannot be converted into cash in a timely manner.
  • Operational risk is another type of risk that deals with the operations of a particular business.
  • Foreign investment risk involves the risk associated with investments in foreign markets.

• Comparing Price Risk and Reinvestment Risk

  • Price risk is positively correlated to changes in interest rates, while reinvestment risk is inversely correlated.
  • Price risk and reinvestment risk both represent the uncertainty associated with the effects of changes in market interest rates.
  • So there is little reinvestment risk.
  • There is, accordingly, more reinvestment risk.
  • In summary, price risk and reinvestment risk are two main financial risks resulting from changes in interest rates.

• Expected Risk and Risk Premium

  • Overall riskiness of an asset is composed of its own individual risk (beta) along with its risk in relation to the market as a whole.
  • A certain amount of risk is inherent in any investment.
  • Systemic risk is the risk associated with an entire financial system or entire market.
  • On the other hand, unsystematic risk is risk to which only specific classes of securities or industries are vulnerable.
  • The term risk premium refers to the amount by which an asset's expected rate of return exceeds the risk free rate.

• Risks Involved in Capital Budgeting

  • In order to discuss this further, we should look into defining the concept or risk.
  • Potential losses themselves may also be called "risks. "
  • For example, market risk involves the risk of losses in position due to movement in market positions.
  • There are different ways to measure and prepare to deal with risks as well.
  • Identify the different risks that must be accounted for in the capital budgeting process

• Risk Aversion

  • Risk aversion describes how people react to conditions of uncertainty and has implications for investment decisions.
  • It attempts to measure the tolerance for risk and uncertainty.
  • People fall under different categories of risk aversion.
  • A risk-averse, or risk avoiding person would take the guaranteed payment of 50, or even less than that (40 or 30) depending on how risk averse they are.
  • A risk neutral person would be indifferent between taking the gamble or the guaranteed money.

• Impact of Diversification on Risk and Return: Systematic Risk

  • As a result, the portion of risk that is unsystematic -- or risk that can be diversified away -- does not require additional compensation in terms of expected return.
  • This type of risk cannot be diversified away, and is referred to as systematic risk.
  • This is the portion of risk that pays the risk premium, because the risk associated with this particular segment of the market is more tightly linked to the risk of the market as a whole.
  • This risk is present regardless of the amount of diversification undertaken by an investor.
  • Diversification theory says that the only risk that earns a risk premium is that which can't be diversified away.

• Making Risk Adjustments

  • New projects sometimes require taking on risks outside of a company's current scope, resulting in the need to adjust risk in the WACC.
  • However, some new ventures will require taking on risks outside of the company's current scope.
  • In this case, adjustments will need to be made to the WACC in order to account for the differing level of risk.
  • It is possible to make such adjustments by figuring the differing risk into the company's beta .
  • The beta coefficient, expressed as a covariance, is the risk of a new project in relation to the risk of the market as a whole.

• Measuring Risk

  • The higher the risk undertaken, the more ample the expected return and the lower the risk, the more modest the expected return.
  • In other words, the higher the risk undertaken, the more ample the return - and conversely, the lower the risk, the more modest the return.
  • This risk and return tradeoff is also known as the risk-return spectrum.
  • Risk is therefore something that must be compensated for, and the more risk the more compensation is required.
  • Risk aversion can be thought of as having three levels: